By SHIRA OVIDE And SVEN GRUNDBERG (WSJ): Microsoft Corp. MSFT -4.90% made a case Tuesday for its $7 billion deal to acquire Nokia Corp.’s NOK1V.HE +33.94% struggling cellphone unit, a blockbuster transaction that solidifies the software giant’s position as a distant No. 3 in the smartphone market.
But the initial reaction was mixed at best, given the long odds both companies face in catching to market leaders like Apple Inc., AAPL +0.53% Google Inc. GOOG +1.58% and Samsung Electronics Co. 005930.SE -1.04% Microsoft’s stock sank 6% in midday trading.
The deal comes on the heels of Microsoft’s announcement that Chief Executive Steve Ballmer will retire as soon as a successor is found. The company’s lagging position in mobile is one of the most serious threats Mr. Ballmer’s successor will need to tackle.
For Nokia, the onetime leader of the mobile-phone business, the deal is a capitulation to the harsh realities of its deteriorating position—a sign that management concluded it is unable to take on rivals like Apple and Samsung on its own.
The companies said late Monday that Microsoft will pay €3.79 billion ($5 billion) to buy “substantially all” of the Nokia business, which includes its smartphone operations. The Redmond, Wash., company will also pay €1.65 billion to license Nokia’s patents, the companies said, bringing the deal to €5.44 billion, or $7.18 billion.
As part of the deal for Nokia’s devices-and-services business, Microsoft will bring aboard 32,000 Nokia employees including CEO Stephen Elop, who is believed to be among the contenders for Mr. Ballmer’s job.
Nokia was already Microsoft’s closest partner in smartphones, with the ailing Finnish company one of the biggest supporters of Microsoft’s phone software.
During a conference call Tuesday morning, Mr. Ballmer said the companies were looking ahead to negotiations in 2014 about ways to modify the partnership they struck in 2011. But they concluded that an outright acquisition by Microsoft was the best way forward.
“It’s quite complicated, but we have been talking for a while about where we wanted to go,” Mr. Ballmer said. “We think we have made excellent, excellent progress with the partnership and yet we also know we have a long way to go and felt in balance that together this is the best approach for both companies’ shareholders.”
Mr. Elop has been hacking costs out of Nokia in the three years since the Finnish company agreed to tether itself exclusively to Microsoft’s Windows Phone operating system. But while Mr. Elop has promised that Nokia’s operating expenditures for its phone business will be cut to half the 2010 levels by the end of this year, analysts say Nokia’s phone sales have fallen even faster.
Nokia said the deal with Microsoft will improve its financial position and “provide a solid basis for future investment in its continuing businesses.”
Microsoft, meanwhile, said it expects the deal to accelerate the growth of its market share and profit in mobile devices. This deal “builds on the phenomenal partnership we’ve built with Nokia,” Mr. Ballmer said during a joint interview late Monday with Nokia Chairman Risto Siilasmaa. He said that because Nokia and Microsoft already work so closely together, it should be a “smooth transition” to integrate Nokia’s mobile business into Microsoft.
The workers being added from Nokia will pad Microsoft’s employee count by about one-third.
“This is definitely major news for Nokia, Nokia employees and Finland,” Mr. Siilasmaa added.
The Wall Street Journal reported in June that Microsoft and Nokia had discussed a sale of Nokia’s mobile-phone business but the talks fell apart over the price of the transaction.
Deal negotiations were sparked by a phone call from Mr. Ballmer to Mr. Siilasmaa just before a February mobile-industry conference in Barcelona. Mr. Ballmer sought to see whether Microsoft could be more than just a partner to Nokia, Messrs. Ballmer and Siilasmaa said in the telephone interview.
The Nokia board met more than 50 times to discuss the possibility of a deal with Microsoft, Mr. Siilasmaa said. As for his part in the deal, Mr. Ballmer said: “This has been a high priority for me.”
Mr. Ballmer didn’t say whether the Nokia deal timing and the announcement of his retirement just over a week ago was a coincidence. The Microsoft CEO did say he called two people, Messrs. Siilasmaa and Elop, just before his retirement was made public, as the two companies were in the final stage of acquisition talks.
The companies said Microsoft is expected to use its stockpile of overseas cash to pay for the Nokia purchase and licensing pact. Microsoft and Nokia said the transaction is expected to close in the first three months of 2014, subject to approval by Nokia shareholders and other conditions.
“For Microsoft, this is a bold step into the future,” Mr. Ballmer said in a note to employees. Mr. Ballmer has been reworking Microsoft around what he calls a “devices and services” strategy—a vision of Microsoft not only producing the software underlying many computing devices, but being more responsible for the personal computers, smartphones and other hardware on which people and businesses rely.
Mr. Ballmer’s strategy, however, has been hamstrung by Microsoft’s weak position in smartphones, a vast and fast-growing business that is reshaping the technology battleground and minting new winners.
Microsoft’s market share in smartphones is about 3% in the U.S., according to comScore.
“So far, the experience of Microsoft in the hardware business has not been positive, so hareholders are understandably apprehensive,” wrote Rick Sherlund, an analyst at Nomura Securities, in response to the deal.
Nokia’s market share and market value have tumbled during the tenure of Mr. Elop, who took over in 2010. Last year, Nokia generated nearly half of its €30.2 billion in revenue from its mobile-phone segment.
One of Mr. Elop’s key moves was cutting the broad alliance with Microsoft in 2011, agreeing to use the software giant’s mobile operating system at a time many smartphone makers were adopting Google’s Android software. So far, the alliance has failed to bear much fruit, with Android powering its way to a dominant share of the market.
With the new deal for Nokia, Microsoft will for the first time control both the smartphone hardware and software teams—matching advantages that companies like Apple have leveraged for years, including easier planning of features and complete control of the customer’s experience, said Van Baker, an analyst at Gartner Inc. But there will also be a smaller group of Windows Phone devices as well, he added, putting further pressure on Microsoft to succeed.
“It’s an all-or-nothing bet,” Mr. Baker said. “They have to be successful in the marketplace because there won’t be anyone else to fall back on.”
Al Hilwa, an analyst at IDC, noted the price was almost too good to pass up for Microsoft, which ended up paying less for Nokia’s smartphone business than the $8.5 billion it did for the communications service Skype in 2011.
The analyst doesn’t expect Mr. Elop’s return to Microsoft to change his standing within the company’s CEO search, which is expected to review both internal and external candidates. Mr. Hilwa argues that the company would be best served by a new leader in the mold of Louis Gerstner, who helped revive International Business Machines Inc. “They need someone who can get all the pieces to work together,” he said.
If the Nokia transactions go through, Mr. Elop will be put in charge of Microsoft’s computing-devices business, in the process pushing down a rung the Microsoft executive recently put in the post.
Asked whether Mr. Elop is now the front-runner for the Microsoft CEO job, Mr. Ballmer said “you shouldn’t read anything into it.”
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